The Case Against the Bernanke-Obama Financial Rescue

Atif Mian and Amir Sufi are convinced that the Great Recession could have been just another ordinary, lowercase recession if the federal government had acted more aggressively to help homeowners by reducing mortgage debts.

The two men — economics professors who are part of a new generation of scholars whose work relies on enormous data sets — argue in a new book, “House of Debt,” out this month, that the government misunderstood the deepest recession since the 1930s. They are particularly critical of TimothyGeithner, the former Treasury secretary, and Ben Bernanke, the former Federal Reserve chairman, for focusing on preserving the financial system without addressing what the authors regard as the underlying and more important problem of excessive household debt. They say the recovery remains painfully sluggish as a result.

At stake in their debate with Mr. Geithner, whose own account of the crisis was published last week — in a book called “Stress Test” — is not just the judgment of history but also the question of how best to prevent crises.

“Our point is very simple,” said Mr. Mian, a professor at Princeton. “Bernanke won. We did save the banks. And yet the United States and Europe both went through terrible downturns.” The focus on preserving banks, he said, “was an insufficient mantra.”

Mr. Sufi, at the University of Chicago, said in a separate interview that he was baffled by claims that the government’s efforts were successful.

“If you actually look at the argument that people like Mr. Geithner make, they almost always point to financial metrics like risk spreads and interest rates,” he said. “But if you look at the real economy, it just tends to come out in our favor.” Millions of Americans remain unemployed almost five years after the formal end of the recession.

Christina Romer, who led President Obama’s Council of Economic Advisers during the recession, said the research by Mr. Mian and Mr. Sufi had convinced her that she and other administration officials underestimated the importance of helping homeowners. But she said Mr. Mian and Mr. Sufi, in turn, had underestimated both the economic impact of the financial crisis and the effectiveness of the government’s response.

“I think what they’ve done is incredibly important, and it does affect how I see things,” said Ms. Romer, a professor of economics at the University of California, Berkeley. “I now think that fiscal stimulus would have been more effective had we also had a more effective housing plan. But to go all the way to saying, ‘The only thing that’s of any use is a housing bailout’ — well, that’s probably not true.”

Mr. Geithner wrote in his book that the administration had tried to help homeowners — and that doing more wouldn’t have changed the trajectory of the recession. “We did not believe,” he wrote, “though we looked at this question over and over, that a much larger program focused directly on housing could have a material impact on the broader economy.”

The Road to a Theory

Mr. Mian, 38, and Mr. Sufi, 37, began their exploration of the boom(and, in time, the bust) in early 2006, shortly after Mr. Sufi joined Mr. Mian as a junior faculty member at the University of Chicago. The two men, who had earned their doctorates at the Massachusetts Institute of Technology, had mutual friends — and Mr. Sufi recalls that Mr. Mian stopped at his office one day to discuss a Federal Reserve analysis dismissing the idea that people were spending the money from home equity loans. “We were like, ‘That’s crazy,’ ” Mr. Sufi remembered. “You just had to look outside to see that it’s pretty obvious that people are using home equity to buy stuff.”

Image

Atif Mian, co-author of "House of Debt."CreditLaura Pedrick for The New York Times

There was a large body of economic research suggesting that a rise in housing values didn’t affect individual consumption very much: The standard view was that for every $1 increase in a household’s home equity, there would be 3 cents to 5 cents in additional annual purchases. But the central insight that has driven much of Mr. Mian’s and Mr. Sufi’s work is that averages can be misleading. They were convinced that as housing prices increased, less-affluent homeowners were spending a larger share of their home equity than wealthy homeowners. They found that the less affluent were spending as much as 25 to 30 cents for every dollar of that equity.

Their work was made possible by a technological revolution that has placed vast quantities of data at the fingertips of economists, allowing them to build theories about the broader workings of the economy from the details of millions of individual lives. The French economist Thomas Piketty and collaborators including Emmanuel Saez, an economist at Berkeley, have used similar financial data to explore the rise of inequality. Raj Chetty, an economist at Harvard, and his collaborators, again including Mr. Saez, have used tax data to explore economic mobility across generations.

Mr. Mian began by calling Equifax, the credit bureau, to ask whether he could buy data showing the debts of individual households, stripped of identifying information. He spoke with a series of flummoxed salespeople who gradually referred him to the head of sales — a woman who happened to live in Hyde Park, a few blocks away in Chicago.

“We now have the ability to observe data in almost all the cases, so it’s just a question of trying to convince the right parties, many of them in the private sector, to provide that data,” Mr. Mian said. “And she was willing to experiment with us.”

In a series of papers, Mr. Mian and Mr. Sufi gradually developed a theory of the boom and bust. They found evidence that lenders flush with cash had made increasingly risky loans. They found, for example, that lending volumes had risen fastest in areas where average incomes were actually in decline. This process continued until the borrowers started defaulting so quickly that the risks became impossible to ignore, and the loans dried up.

When housing prices crashed, people lost their equity, but their debts did not disappear. They cut back on consumption, and the economy fell into recession. And, importantly, the households with the largest debt burdens cut back the most. Mr. Sufi and Mr. Mian found that for every $10,000 decline in home values, families with high debt burdens reduced spending on autos by $300, while families with low debt burdens reduced spending on autos by just $100.

The housing crash, in other words, took away the greatest share of wealth from the part of the population that had been most likely to spend it. The point, Mr. Mian and Mr. Sufi said, was that the economy had crashed the financial system.

The Obama administration considered several ways to reduce mortgage debts during the heart of the crisis. It promised to pursue a few, too, including empowering bankruptcy courts to forgive debts, paying lenders and buying up loans. But ultimately, the administration adopted a limited aid program and gambled that an economic recovery would take care of the problem. Mr. Mian and Mr. Sufi are not particular about which method of reducing debt would have been best; their point is simply that the government, by failing to do more, inhibited the recovery.

Their research is now widely cited as demonstrating that the overhang of household debt contributed to the slow pace of the recovery; one such citation came in the 2012 Economic Report of the President. Alan Krueger, a Princeton economics professor who wrote the report and was then the chairman of the president’s Council of Economic Advisers, said he considered their work important for suggesting that in areas where the economic recovery was slow, “that weak demand was the source of their economic problems, not credit market failures.”

Mr. Sufi said he was delighted that policy makers were listening. “It was always the goal for me to write research that would be policy-relevant,” he said. “People asked me what I wanted to be when I grew up, and I’m pretty sure I just wanted to be right.”

Yet some admirers of their research, like Ms. Romer, wonder whether Mr. Mian’s and Mr. Sufi’s book overstates the significance of their findings by asserting that debt was the driving force in the recession.

Image

Amir Sufi, co-author of "House of Debt."CreditAlex Wroblewski for The New York Times

Americans lost a similar amount of wealth during the housing crash as during the collapse of Internet-related stocks in 2000, but the economic consequences of the housing crash were much larger. The difference, in the view of Mr. Bernanke, the former Fed chairman, and other economists, is that the housing crash precipitated a financial crisis. Mr. Bernanke has noted that the worst of the economic downturn did not begin until the markets crashed in the fall of 2008, and that it ended once the financial crisis was arrested. The recovery has been slow, he has said, because of factors including cuts in government spending and Europe’s malaise.

“There were weaknesses in the financial system that transformed what might otherwise have been a modest recession into a much more severe crisis,” Mr. Bernanke said in a 2012 lecture at George Washington University. “It was not just the decline in house prices,” he added. “It was the whole chain.”

Why Subsidize Debt?

At times, Mr. Mian and Mr. Sufi write as if debt is simply bad. In interviews, their views are more nuanced. They both have mortgages. They recognize that borrowing by governments and businesses can be productive. But they say the rules of debt are evolving in a direction that is bad for borrowers and bad for society.

The people taking the risks are the ones with the least financial wherewithal to absorb setbacks. As a result, during an economic downturn, they tend to cut their spending most sharply. Standard economics sees little problem in this, because it assumes that interest rates will fall as a result, inducing others to spend more. But in a big downturn, rates would need to fall below zero to create a sufficient incentive. The only way out, Mr. Mian and Mr. Sufi say, is for society either to forgive the debts, or to step in and impose some of the losses on the creditors instead of the borrowers.

“There was more of an agreement in the past that in the face of aggregate shocks, debt would be forgiven,” Mr. Sufi said. “Go back to the Code of Hammurabi, and it says that if no rain comes, all the debts are going to be cleaned. Our problem with debt in the modern world is that that implicit agreement seems to have broken down. When we have aggregate shocks now, you have people yelling that people are irresponsible.”

At a minimum, Mr. Mian and Mr. Sufi say, they cannot understand why the government encourages borrowing, for example, through tax deductions for mortgage interest payments.

“You need some kind of limit on where people can smoke, and you need some kind of limit on debt,” Mr. Mian said. “When there is an activity that is dangerous, you should tax it in one way or another. And instead we have a system that actively subsidizes debt.”

What we talk about when we talk about household debt, of course, is mostly mortgages. And the two men have a proposal for making mortgages better: Lenders would agree to ease debts during downturns; in exchange, lenders would get a percentage of any gains from the eventual sale of a home.

Academics often find that in Washington, their diagnoses are taken more seriously than their prescriptions. And so it was when Mr. Mian described this “shared-responsibility mortgage” to the Senate Banking Committee in October 2011.

“I have to say, that’s one of the oddest proposals I’ve ever heard,” said Senator Bob Corker, a Tennessee Republican who has a reputation for being among the more financially astute members of Congress. “I doubt that will make it into the mainstream here.”

The professors profess themselves unfazed.

“Someone needs to talk about how things should be, and then hope that someone else takes it up,” Mr. Mian said.

Mr. Sufi added, “We’re just trying to get people to appreciate what debt is, and what it does.”